Today, the Trump administration published their full budget request for fiscal year 2018. The budget is basically par-for-the-course with recent Republican budgets— doubling down on the austerity policies that have been harming American households for about a decade. But besides containing cruel cuts and deeply-dodgy economic assumptions, this proposal should also dispel any last remaining hope that fiscal policy under the Trump administration would boost, rather than drag, on growth and jobs. Were this proposal enacted, it would put a large and rapidly growing drag on economic growth going forward. All else equal, job-losses stemming from this budget’s spending cuts would total 177,000 in 2018, 357,000 in 2019, and 1.4 million in 2020. While it gets increasingly hard to estimate precise numbers further into the future, the fiscal drag just increases dramatically after 2020.
The economic intuition for why the Trump budget’s cuts would hinder growth is simply that they would reduce growth in economy-wide spending, or aggregate demand. It is always possible that the spending slowdown caused by the Trump budget could be neutralized by spending increases in other parts of the economy. Before the onset of the Great Recession, it was thought that this spending increase could be reliably engineered by the Federal Reserve lowering short-term interest rates. Since the Great Recession, however, the economy saw seven years of historically slow recovery even while the Fed held short-term rates at zero (and undertook other measures to boost growth). The reason for this slow growth despite expansionary monetary policy is clearly historically austere public spending.
This should make clear that while the Fed certainly has the ability to curtail growth by raising interest rates, their ability to offset a negative fiscal shock by lowering rates seems severely constrained. Given that a monetary policy response should not be relied on to neutralize the negative fiscal shock of the Trump budget and the AHCA, we think these estimated job-losses should certainly inform the debate. Further, the federal funds rate (the rate the Fed lowers to offset negative demand shocks) sits at just about 1 percent today, meaning the Fed simply doesn’t have much room to boost the economy in response to contractionary fiscal policy that begins next fiscal year and then ramps up. For reference, in the past five recessions, the peak-to-trough change in the federal funds rate as the Fed aimed to stop the contraction and spur recovery was over 3.5 percent.
To measure the fiscal drag that would result in the short-run from the Trump administration’s budget, we compare its spending to the CBO’s January baseline over fiscal years 2018 and 2019. While the Trump administration would boost discretionary defense spending by about $100 billion, this is more than offset by the combination of $73 billion in nondefense discretionary cuts and $78 billion in mandatory spending cuts over the period. Combined, this is a decrease of $51 billion in spending over fiscal years 2018 and 2019.
A full account of the effects on GDP and jobs from Trump fiscal policy overall would include the effects from revenue changes intended by the administration. However, the administration has chosen to assume that a tax cut which Tax Policy Center estimated would cost about $6 trillion will somehow be revenue-neutral and that economic growth will quickly ramp up to 3 percent. This renders their revenue numbers basically useless. Even budget direct Mick Mulvaney has admitted that these assumptions are more a sign of administration laziness in not wanting to include more materials with their budget release than of any intellectual inquiry.
So until more-reasonable numbers on revenue changes are provided, we will just focus on the fiscal drag provided by its spending cuts. All else equal, we estimate that these cuts would decrease GDP by 0.1 percent and slow job growth by 177,000 jobs in fiscal year 2018, decrease GDP by 0.2 percent and slow job growth by 357,000 in 2019, and decrease GDP by 1 percent and slow job-growth by 1.4 million in 2020. Even in these later years, the Fed would still be hard-pressed to provide monetary stimulus anywhere near large enough to offset the fiscal drag.
Beyond fiscal year 2020, forecasting the room available to the Fed to offset fiscal cuts becomes hugely uncertain. But at the same time, in terms of fiscal drag the years after 2019 are when the Trump budget is at its worst. To get a sense of the magnitude, consider the spending cuts in fiscal year 2027 (the last year estimated). The Trump budget proposal would cut nondefense discretionary by about $304 billion, cut mandatory spending by about $386 billion, and cut defense spending by about $19 billion. Altogether this is a cut of $709 billion, or about 2.5 percent of fiscal year 2027 GDP. We can’t estimate the effects this would have on GDP or jobs that far in the future, but this is clearly a mammoth fiscal drag, so we certainly better hope that other parts of the economy are firing well then.
And the policies in the budget make it clear that the fiscal drag would only get worse after 2027. Policymakers would need to think hard about how to mitigate the immense drag that would be created by the Trump budget proposal far into the future. Far from unleashing 3 percent growth, this budget is a disaster waiting to happen for growth.